Don’t diversify beyond 40 stocks

How diversified is your diversified equity scheme? If you have glanced through its December portfolio, you would’ve found out that it is not that diversified.

A close look at the portfolios of equity diversified schemes reveals the total number of stocks in the portfolio also varied from 10 to 72, with the average number of stocks of around 35 stocks per scheme. Obviously, 10 stock portfolio mean it is overly concentrated, whereas 72 stocks qualify for over-diversification. Three to five stocks formed a sizeable part (20% plus) of the portfolio of most schemes. Even their exposure to a single stock was respectable 5% or above.

What does this mean for investors in these schemes? After all, investors have parked their money in these schemes because they wanted to diversify their portfolio of stocks. Does such a concentration of the portfolio actually defeat the very purpose of investment objective? Or, is it a case of fund managers sticking to the principle that too much diversification is injurious to health?

“In fact, very few schemes can be called diversified. If an investor is investing in two or three schemes of the same fund house, chances are that he would be holding the same three to five stocks in all these schemes,’’ says an industry player. “To be a true diversified scheme, one needs to diversify across sectors and stocks,’’ he adds. “It is only natural that most schemes would have the same stocks in the top five holding. In these markets, everyone wants to be safe and they tend to put money in top five stocks in terms of market capitalisation as they are more liquid,’’ says a fund manager.

That calls for one question: What is an ideal diversified portfolio for a diversified equity scheme? “Ideally, the portfolio should have 35-40 stocks. Beyond that it will become unmanageable,’’ says Devendra Nevgi, CEO of Quantum Asset Management Company. Though his AMC doesn’t take sectoral calls, the percentage of a single stock it can hold in its portfolio is limited to 5-7%. “We have a strict internal risk management system in place. Even if a stock looks extremely attractive, I can’t go beyond the prescribed limit.’’ Quantum Long Term Equity Fund has a total of 32 stocks in its portfolio and its single top holding accounts for 4.95%, three stocks for 14.57% and five stocks for 23.56% of the total portfolio.